Selling Big Losers: Why and How

Let’s say that, in spite of your best intentions, the good advice you’ve received from advisors and your sincere best intentions, you are sitting with a stock in your portfolio that represents a huge loss. Or maybe more than one.

Maybe you went on vacation during earnings season and one of your stocks reported a bad quarter and investors threw it off a cliff. Or it might be that the stock has been drifting downhill for months, but you love the story and you’ve just been watching in dismay, hoping that it will go back up. It may even be that you’re just angry that the stock has tanked and you’re just not going to capitulate. (After all, if you don’t sell it, it’s not a loss, right?)

There are a few ways to rationalize holding on to a big loser, but not many. A stock may be a core holding in your portfolio that pays a good dividend. It may be a value play and you have the fundamentals to support your long-term projections for its ultimate success. Or, maybe you’ve just told yourself it’s an “investment,” and all it needs is time.

But, chances are good that you’re holding onto this loss out of hope (misplaced), sadness (appropriate, but not a good stock advisor) or love of the stock itself. And believe me, any growth investor who’s been around the block a few times has been through all of those bad excuses, and more.

So my message today is that it’s time to kick those broken stocks to the curb and get on with your investing life. It’s not easy, but it will make you (and your portfolio) feel much better as soon as you do.

Why sell? There are three big reasons. First, you will protect yourself from further losses. (If you think the stock has gone as low as it can go, you’re probably wrong. A quick look at the chart for Qihoo 360 (QIHU), which has been tumbling downhill for weeks, or a glance at what happened to FireEye (FEYE) in March and April will give you the idea in very graphic terms.)

Here’s a daily chart for QIHU.

And here’s a weekly chart for FEYE. The stock has probably bottomed at this point, but five months after ending its March/April plunge, it hasn’t regained much of that loss.

Second, you will free up the remaining capital for use in owning a healthier stock with better growth prospects.

Third, and maybe most important, by biting this bullet you will help yourself to avoid having it happen in the future. Chunking your big losers into the trash will help you to learn the lesson that hope, while it’s an okay reason to buy a stock, is a terrible, terrible reason to hold onto one. And having the gumption to jettison losses will reinforce your resolve to use appropriate loss limits in the future.

As far as how to go about selling, my advice is just to hit the dang “SELL” button. Yes, you can wait for an uptick, but that often gives rise to the temptation to hold on in hopes that the stock will recover. But big losers are often damaged, and true recovery may not occur for many quarters, if ever. And if you’re worried that the stock might just blast off to the upside as soon as you sell it, ask yourself this question: If you had to guess which stock is more likely to rally, which one would you pick, your wounded bird of a stock, or a fresh new stock in an uptrend? If your brain-housing module is in good working order, I think you’ll make the right decision.

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My stock pick for today is partly an admission. I write Cabot China & Emerging Markets Report, and I prefer to select my featured stocks from the pool of emerging markets issues. It’s nice to show off when things are going well.

But I’m also a realist, and I think making money is more important than my personal preferences.

And with most of the stocks in my investment universe feeling the weight of investors’ hesitation about buying Chinese issues, I’m going to go domestic.

My pick today is Ambarella (AMBA), which was also featured in Cabot Top Ten Trader on September 8. One look at the chart will probably tell you why I like this stock. AMBA has been in an uptrend since early May and has been exceptionally strong since early August. (The decline during July was a classic shakeout that wrung out many who bought near the interim top at 34.)

The story behind Ambarella is simple. If you love GoPro (GPRO), the dominant maker of rugged action cameras and mounts, but don’t want to jump into a stock that has more than doubled since August, AMBA makes good sense.

That’s because Ambarella makes the high-definition image processing semiconductors and software that create and publish the HD videos and stills that make GoPro cameras so attractive. And just for good measure, Ambarella’s chips also power the products of DropCam, GoPro’s biggest rival.

AMBA isn’t what I’d call a perfect setup. It’s been taking off with such power that a correction looks inevitable; after all, stocks don’t go straight up for long. But the stock put in a nice long base during the first seven months of 2014, so it has a good foundation for its advance.

Just try to buy on a pullback of a couple of points and keep your stops in good working order.

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Market Update

From Cabot Dividend Investor

The market continues to lean bullish, with warning signs. While the Dow has been hitting all-time highs, the S&P has gone nowhere for two weeks and the Nasdaq has actually lost ground. Investors seem to be deserting “risk-on” assets, leading to underperformance in the Russell 2000 (IWM) and high-growth sectors including Semiconductors (SMH) and Biotechs (XBI).

On an individual stock level, earnings reactions have been leaning negative. Companies that disappoint are punished severely, while companies that beat are rewarded weakly, if at all.

Meanwhile on the fixed income side, Friday’s hot payrolls report increased inflation expectations and drove bond yields higher over the weekend. But yesterday’s North Korea panic drove investors out of stocks and into conservative assets, driving bond yields lower once again. “Risk-off” classes, including utilities, benefited.